21.58. The number and variety of superannuation schemes in existence make it difficult to effect any fundamental change in the tax treatment of superannuation funds, particularly if such change is directed to a restructuring of the benefits provided by the schemes and the contributions that may be made to them. The long-term nature of these funds and the expectations arising from membership of them have been referred to at the beginning of the chapter. Proper transitional arrangements are necessary to reduce the aspect of retrospectivity to which amendments to the law may give rise.

21.59. The findings of the Committee are set out in the form of two views. The first view proceeds on the basis that, while the obvious anomalies and shortcomings of the existing tax regime ought to be corrected, the basic structure of superannuation and other retirement provisions should be left untouched. The second view recommends some fundamental changes which for their implementation would have to be confined to new schemes following amendment to the law. The proposals in the second view take full account of the proposals in the first view and are expressed partly as differences from the latter.

21.60. After the paragraphs setting out the second view some observations on the advantages and disadvantages of the two views are made. It should not be thought that the use of the terms ‘the first view’ and ‘the second view’ indicates a preference: the approach in the form of two views has been adopted for ease of exposition.

The First View

21.61. This view proceeds to comment on section 26 (d), referring to the ultimate position and the transitional arrangements by which it is reached. The discussion then moves to the income of approved superannuation funds and the conditions to be observed if the income is not to be subject to tax. Contributions to such funds, provisions for self-employed persons and the ‘30/20 requirements’ are referred to before the proposals in the second view are set out.

21.62. Section 26 (d) is a section of the Act by which practically every taxpayer who has been or is in employment is likely to benefit at least once in the course of his working life. In many cases, both the benefit and the corresponding loss in potential revenue are substantial. The weaknesses of the section, the inequities which flow from it and some of the methods adopted to abuse its provisions have already been outlined.

21.63. The problems inherent in making any change in this area are not to be underestimated. The present tax treatment of lump-sum retiring allowances has been with us since 1915, making it one of the oldest, best-known and most entrenched aspects of our income tax structure. Many people, particularly those nearing retirement, have made their plans for the future on the assumption that the amounts they receive on retirement would continue to be taxed on the present basis. The legitimate expectations of such people deserve the utmost consideration. To change suddenly to a harsher basis of taxing such receipts would generate justifiable complaints that the legislation was retrospective in nature, since the amounts concerned would normally have accrued over a considerable period—possibly over the entire working life of the person concerned.

  ― 362 ―

21.64. There is nonetheless a limit to the extent to which concern over such retrospectivity can be allowed to influence recommendations for a fundamental change in the tax structure. Pushed to its extreme such an argument leads to a legislative straitjacket where it is impossible to make changes to any revenue law for fear of disadvantaging those who have made their plans on the basis of the existing legislation. It would, for instance, prevent any change to estate duty legislation, since the change might conceivably disadvantage the estate of somebody who had accumulated his wealth and done his estate planning on the basis of the present legislation.

21.65. The Committee is acutely aware of the difficulties in reconciling the considerations advanced in the above two paragraphs but believes that some attempt must be made to do so. The inequities inherent in section 26 (d) are likely to become greater rather than less in the future and, if the problems involved in making a change now are formidable, they are unlikely to diminish as the years go by.

21.66. There is a very strong tradition in Australia of lump-sum rather than pension benefits upon retirement. The reasons for this, and in particular the relevance of the existing tax structure, can be debated endlessly and the Committee sees no merit in expressing an opinion on this point. It recognises that there are valid reasons for many people wishing to receive a lump sum at retirement; and indeed some payments received on termination of employment, such as accrued holiday and long-service leave pay, can in practice only be received in lump-sum form. The Committee does not think that the tax system should be used to discourage people from choosing a lump sum rather than a pension at retirement. If a person is entitled to a lump sum he should be quite free to receive it, but he should not gain an unwarranted tax advantage by so doing. The Committee notes the view of the National Superannuation Committee of Inquiry, in its Interim Report (1974), that steps be taken to achieve parity of treatment for benefits received as pensions and those received as lump sums.

21.67. What follows in relation to section 26 (d) is in two parts. The first deals with the ultimate situation to which the tax system should move in lieu of the present section 26 (d), and the second deals with the type of transitional arrangements that might be appropriate in order to avoid too sudden a change for those nearing retirement.

21.68. The ultimate position. It is proposed that section 26 (d) be repealed and replaced by provisions to the following effect.

21.69. With the exception of payments that can validly be regarded as received upon age retirement or earlier retirement because of ill health, all amounts received by a taxpayer upon or in consequence of the termination of an office or employment should be included in full in taxable income and taxed in the ordinary way. This inclusion should extend to amounts received from a superannuation fund prior to the termination of employment. However, where a taxpayer receives a lump-sum retiring allowance or lump-sum benefit from a superannuation scheme, he should be exempted from tax if, within three months of the receipt of the amount, he applies it as a contribution to another approved superannuation fund.

21.70. Where retirement occurs on account of age or ill health the taxing of the lump-sum retirement benefit is also proposed. However, the additional tax that would be incurred under the progressive personal income tax scale were the total amount received to be included in taxable income in the year of receipt could be onerous. Accordingly, it is proposed that the spreading provisions outlined later in paragraph

  ― 363 ―
21.77 should be available in respect of lump-sum retiring allowances, superannuation benefits, payments under service contracts and accrued long-service leave payments received upon the retirement of a taxpayer at the age of fifty-five or over, or upon his earlier cessation of work through ill health. To cater for certain employees such as members of the armed forces who retire before fifty-five, this concessional treatment could be extended down to the age of forty-five if the Commissioner is satisfied that it is reasonable for a taxpayer in that employment to retire before fifty-five. There seems to be no reason, however, for extending any concessional treatment to lump-sum receipts representing accrued holiday pay.

21.71. Lump-sum amounts received by self-employed persons after the age of fifty-five (or upon earlier cessation of work through ill health) should be accorded similar treatment to amounts received by employees. These amounts would include lump sums received for loss of office, amounts received from a superannuation fund and amounts received upon the termination of employment of a person who is both an employee and a self-employed person.

21.72. Any part of a lump-sum superannuation benefit received by an employee or self-employed person representing contributions made by that person which have not been an allowable deduction under section 82H should be exempt from tax.

21.73. It is to be noted that the ‘bunching’ effect of a large taxable lump sum can be mitigated by the taxpayer, if he so desires, making use of the income equalisation scheme recommended by the Committee in Chapter 14. It would however be necessary to restrict the availability of the income equalisation scheme for these amounts to circumstances where ‘forward spreading’ of the amount has not been availed of.

21.74. Payments received as consideration for entering into a restrictive covenant (such as a covenant not to join a competitor of the employer) present considerable difficulties. On the one hand, where the transaction is at arm's length and bona fide it could be argued that it is an affair of capital, with the employee agreeing in return for a lump-sum payment to give up a substantial future area of activity. On the other hand, there is the possibility of such restrictive covenants being used merely to cloak what is in substance a retiring allowance. On the whole it is thought best simply to give the Commissioner power to examine payments made under such agreements and include them in assessable income if he is not satisfied that the amount received by the employee corresponds to the area of future activity forgone.

21.75. The acceptance of the views above would mean that all lump-sum retiring allowances would be taxable in full, subject to whatever ‘spreading’ arrangements are thought appropriate. If the person receiving the amount wishes to use it to provide a pension for himself at retirement, then as long as the pension is going to be assessable there should be no liability for tax on the lump sum. Where a person receives such a sum, he should be permitted to exclude it from his assessable income provided that he applies it immediately to the purchase of an annuity to commence not earlier than his sixtieth birthday (or earlier cessation of work owing to ill health). The subsequent commutation to a lump sum of any such annuity would be taxed as if it were the receipt of a lump-sum retiring allowance.

21.76. In paragraph 21.70 it was emphasised that it would be inequitable to tax as income in the year of receipt the whole of any lump-sum retirement benefit. Various methods are available to ‘spread’ the amount received over a number of years. Two methods in particular are worth close attention:

  ― 364 ―

  • (a) The amount received is divided by 10 and the result added to the taxable income of the taxpayer in each of the ten succeeding years. This is an attempt to approximate the tax treatment of a pension, the ten-year period being close to the average life expectancy of a person at retirement. Since it is undesirable to defer the tax until up to ten years after the amount has been received, it would be necessary to levy provisional tax at the time of receipt and then give progressive credits for this provisional tax against the tax liability of the taxpayer over the next ten years. Because the final tax liability attributable to the lump sum is not known until more than ten years after its receipt, difficulties will arise in the event of the death or emigration of the taxpayer before the expiration of that period.
  • (b) Alternatively, there is the method now adopted in the United States under the Pension Reform Act 1974. This involves looking only at the lump-sum receipt and ignoring all other income of the taxpayer. After an initial exemption of $US10,000, the lump sum is divided by 10 and the tax on an income of this amount is calculated and the result is multiplied by 10 to give the total tax payable. Since the calculation pays no regard to the other income of the taxpayer, it is necessary to have provisions for aggregating lump sums received from different sources and at different times. Under the United States legislation there is a six-year ‘look-back’ period whereby the tax on a lump sum is calculated having regard to all such lump sums received in the preceding six years. This method has the considerable merit of simplicity in that the tax liability attributable to the lump sum is determined once and for all at the time of its receipt. However, since it ignores the other income of the taxpayer it might be thought to offend notions of equity and progressivity in the income tax system.

21.77. On balance the Committee favours the new United States treatment and proposes that it be adopted with certain modifications. There would seem to be no justification for any initial exemption and the look-back period should be extended to ten years. In view of the differences between personal income tax scales in the United States and Australia (see Table 14.A in Chapter 14), the forward-spreading period should be fifteen rather than ten years. However, the Committee has proposed changes in the rate scale, and if these are adopted the forward-spreading period will need to be reconsidered.

21.78. Reference has already been made to the need to enable a person who receives a lump-sum retiring allowance to defer the tax on the amount received by purchasing a deferred or immediate annuity. It is also anticipated that the proposals made earlier in paragraphs 21.68–21.77 will lead to a reduction in the present bias in favour of lump-sum superannuation benefits. Many superannuation funds however are geared only to providing lump-sum benefits, and in particular those that operate on the money accumulation principle would find it almost impossible to underwrite pensions themselves. Thus many employees who might prefer to receive a pension could be forced into accepting a lump sum on which they would be taxed. This problem could largely be solved by permitting life insurance companies to sell annuities to the trustees of approved superannuation funds at the time of the employee's retirement, the investment supporting the annuity to be subject to the same tax treatment as the investment supporting a pension paid directly from the fund itself. At the moment, apart from the inbuilt bias towards lump sums, there are two factors militating against a life insurance company offering annuities on realistic terms under these circumstances.

  ― 365 ―

  • (a) There is considerable uncertainty as to whether such contracts are ‘superannuation policies’ for the purpose of the exemption from tax of that part of the life insurance company's investment income derived from assets held in respect of those contracts. This uncertainty should be removed by making it quite clear that annuity contracts of this type are ‘superannuation policies’ for the purposes of the Act.
  • (b) More importantly, the Life Insurance Act 1945–1973 specifies that the reserves held by a company in respect of annuity business must be calculated on a certain minimum basis. Under present conditions, this basis is unnecessarily conservative. This leaves a life insurance company with two choices as far as the underwriting of annuity business is concerned. It can write the business on a realistic basis, in which event the rest of the policy-owners have to provide a large initial subsidy to the business, thus putting a brake on the volume of annuity business the company can undertake without severely disadvantaging the other policy-owners; or it can write the business on the basis used in the Life Insurance Act for calculating the reserves, thus disadvantaging the annuitant. It is essential that the relevant provisions in the Life Insurance Act be amended to enable annuity business to be freely undertaken on a realistic basis. The National Superannuation Committee of Inquiry has made a similar recommendation.

Consistent with the tax treatment of lump-sum benefits, it appears advisable to provide that if an annuity acquired by the trustees of a superannuation fund, or an ordinary superannuation pension, is commuted into a capital sum, that capital sum will be taxed as if it were the receipt of a lump-sum benefit from a superannuation fund.

21.79. If the foregoing proposals for replacing section 26 (d) are adopted, most of the avenues for avoidance and inherent weaknesses of the present tax system in the area of superannuation and retiring allowances will be removed. Nonetheless, in order to ensure parity of treatment between unfunded retiring allowances and benefits paid from superannuation funds, it is proposed that section 78 (1) (c) be amended and strengthened to make it clear that retiring allowances paid by an employer are deductible only under this section and only up to the amount that would be allowed as a reasonable benefit from an approved superannuation fund. For this purpose, amounts receivable in consequence of retirement or cessation of employment from a superannuation fund should be taken into account in determining whether the amount paid was in fact reasonable.

21.80. Transitional provisions: lump-sum retirement benefits. The opinion has been expressed that the main difficulty in making changes to the present basis of taxing lump-sum retirement benefits derives from the fact that the taxpayers have built up expectations and often made plans on the basis of the existing provision. The problem of dealing with such legitimate expectations was the reason why the recommendations of the Spooner Committee on this matter in 1951 were ultimately not followed. This difficulty, while not to be underrated, is nonetheless not insuperable and to this end transitional provisions should be adopted which ease, as far as possible, the change from the old basis of taxation to the one recommended above. These transitional provisions should be such as to err, if at all, on the side of generosity and ease of understanding. The Committee has given a great deal of attention to the practical effects of the various possible types of transitional provisions.

  ― 366 ―

21.81. Nonetheless it is necessary to distinguish legitimate expectations from mere hopes. A person who is one day from retirement obviously has a legitimate expectation that his retiring allowance or superannuation benefit which may have accrued over forty years or more will be accorded the present treatment. On the other hand, it is unrealistic and unnecessary to give much weight to the expectations of the twenty-year-old as to the tax treatment of his ultimate retirement benefits.

21.82. In theory the approach might be that only amounts which can be regarded as accruing after the date of the legislation should be subject to the new treatment. This would prevent radically different treatment of the man who retires one day after that date and the man who retires one day before. It would also largely remove any complaints about retroactivity in the new legislation. There are certain types of payment, however, which are currently subject to tax only as to 5 per cent under section 26 (d) for which transitional provisions of this type are either undesirable or unworkable. Accrued holiday pay, for instance, would present administrative difficulties on apportionment and in any case should not be regarded as a retiring allowance.

21.83. The method by which such payments should be apportioned into pre and post legislation amounts is open to some debate. With superannuation entitlements, for instance, it might be argued that the amounts accrued in respect of each member of a superannuation fund at the crucial date should be calculated at that date and those amounts should be the amounts subject to exemption. Similarly with longservice leave entitlements, the entitlement of each person could be calculated at that date having regard to his current salary and the amounts so calculated would eventually be exempt. On balance this approach is not favoured, largely because of the administrative complexity involved and the extremely high compliance costs for employers, employees and superannuation funds.

21.84. If an apportionment method is to be used, then the benefit should be regarded as accruing uniformly over the period of employment (or self-employment in the case of a self-employed person) and should be apportioned accordingly into the amount accrued before the commencement of the legislation and the amount accrued after such date. It is to be noted that this assumption of uniform accrual will usually be generous to the taxpayer, since in practice most such amounts accrue at an increasing rate. The apportionment should only apply to amounts attributable to the employment (or self-employment) of the taxpayer current at the date of the legislation and, for administrative reasons, it may be necessary to regard the employment (or self-employment) as having commenced no earlier than the age of twenty.

21.85. The apportionment method of the latter type would be difficult to administer and give rise to disputes. The greatest difficulties would be in the need to establish the date of commencement of employment (or self-employment), particularly where there has been a break in employment.

21.86. If the apportionment method is adopted so as to tax only a portion of a lump-sum receipt, there is no reason for retaining the present inclusion in taxable income of 5 per cent of the balance. The 5 per cent is a derisory figure and serves only to confuse and complicate the picture. Accordingly, it is proposed that any amount to be given concessional treatment under these provisions should be totally exempt.

21.87. An alternative approach, and one that is considerably simpler than the apportionment method, would be to phase out section 26 (d) by providing that the figure of 5 per cent be progressively increased to 100 per cent over a lengthy period. This method has the advantage of certainty in that the percentage inclusion at any

  ― 367 ―
time would be the same for all taxpayers and would apply regardless of whether the payment involved arose from an employment (or self-employment) entered into before or after the date of the legislation. It would, of course, be necessary to provide that certain superannuation payments received by self-employed persons (and some employees) which are currently wholly exempt should be brought within the escalating inclusion provisions.

21.88. The choice of the period over which section 26 (d) should be phased out involves conflicting considerations. On the one hand, if the period is too short then those employees who are now middle-aged would have just cause for complaint; moreover, there may be a tendency for employees to change jobs immediately so as to receive an almost totally exempt lump sum instead of waiting until the normal retiring age and receiving an admittedly larger benefit which will be subject to a higher rate of tax. On the other hand, it is undesirable that the transitional period should be excessively lengthy. A long transition with its slowly escalating rate of inclusion is very generous to those persons, often relatively young, who change jobs and receive superannuation benefits and lump sums in lieu of accrued long-service leave.

21.89. On balance the second approach is favoured largely because of its certainty and simplicity. The period during which section 26 (d) is phased out should not be less than twenty-five years or more than forty. Furthermore, to avoid sudden jumps in the rate of inclusion, the adjustments should be made at quarterly rather than annual intervals.

21.90. The transitional provisions (of whatever type) should be available in respect of lump-sum retiring allowances, benefits from superannuation funds, amounts paid under service contracts or accrued long-service leave payments. They should not however be available in respect of amounts representing accrued holiday pay. These latter amounts should be regarded as income and taxed accordingly.

21.91. The amount that is not exempted under the transitional provisions would be eligible for forward spreading as outlined in paragraph 21.77 if received after the age of fifty-five or upon earlier retirement because of ill health.

21.92. There is some difficulty in devising an equitable method of taxing benefits paid upon the death of an employee, and amounts received from a superannuation fund upon the death of a self-employed member of that fund. At present such amounts, if paid as a lump sum, are totally exempt from tax. Strict logic would seem to suggest that if such lump sums received during life are to be taxable they should also be taxable if received at death. To exempt them at death is to give markedly different treatment to the man who dies one day after receiving his retirement benefit (and paying tax thereon) as compared to the man who dies one day before retirement and whose retirement benefit is thus received, tax-free, by his widow or estate.

21.93. The Committee will be recommending in Chapter 24 that such amounts be included in the deceased person's dutiable estate, though it would not be possible to include in the dutiable estates pure ex gratia payments made by the employer to the widow or dependants of a deceased employee. The Committee believes that to subject such benefits to income tax as well as to estate duty would be undesirable and unwarranted. Accordingly, no change in the present system is recommended.

21.94. The income of superannuation funds. As stated in Section I of this chapter, the Committee believes that the present exemption from tax enjoyed by most superannuation funds can be justified. It encourages the provision of the future needs of employees both by themselves and by employers recognising a moral obligation. It

  ― 368 ―
also serves to correct the bias against saving inherent in a system of tax on income and helps promote capital formation.

21.95. Furthermore, if the benefits that eventually emerge from a superannuation fund are to be taxed, the contributions to the fund, whether made by employer, employee or self-employed person, should be an allowable deduction at the time they are made.

21.96. The general propositions advanced in the two preceding paragraphs must, however, be qualified in the following manner:

  • (a) The amount of fund income exempt from tax must be subject to some limitation, preferably by the imposition of limits on the benefits that can be provided by such funds and thus, indirectly, on the assets and income of the funds.
  • (b) Exemption of the income of, or deductibility of the contributions to, such funds is not justified unless there is some assurance that the funds will only provide benefits in the event of age retirement or earlier death or ill health. In other words, there must be some assurance that the savings undertaken through such media are indeed long-term savings.

21.97. Ignoring foreign superannuation funds, there are at present four different provisions of the Act under which a superannuation fund may gain total or partial exemption from tax on its income. These four different types of fund should be replaced by an omnibus category of ‘approved superannuation fund’. The fact that government superannuation funds are subject to no controls and do not have to satisfy the same criteria for exemption as do private sector funds is open to question. Similarly, if some funds have to comply with the 30/20 requirements there seems no good reason why others should not be under a similar obligation.

21.98. To gain approval, such a fund should satisfy the criteria set out in the following paragraphs, in addition to those outlined earlier in paragraphs 21.37–21.42.

21.99. The benefits to be provided by the fund must not be excessive and the amount of the fund should not be excessive having regard to the benefits to be provided. The existing ‘reasonable benefits’ limits have been outlined at paragraph 21.43 and these are regarded as satisfactory in principle since they take into account the earnings of the person concerned (except in the case of funds for self-employed persons) and impose overall limitations on the dollar amount of the benefits. However, a stricter approach should be taken to the period of service necessary to qualify for maximum benefits: in this respect it is noteworthy that the new superannuation scheme for Australian Government employees proceeds on the basis of a thirty-year period. It is proposed that the scale of reasonable benefits which may be provided by an approved fund should only apply in the case of an employee with at least thirty years service at retirement and should be reduced for those with lesser service. Furthermore, greater attention should be paid to the current value of assets of superannuation funds, since the benefits actually paid will in many cases be based on current values at that time.

21.100. There should be power to reopen past assessments of a fund if, at any time, its rules are changed to permit the payment of benefits before the death or retirement of its members.

  ― 369 ―

21.101. The fund should be debarred from investing (except to a minor extent) in shares of or loans to an employer of the members of the fund. Such ‘investment’ is undesirable from the standpoint of the security of the members’ benefits, since if the employer's business fails they lose not only their jobs but also such part of their superannuation entitlement as is represented by the investment. If this proposal were to be adopted, a transitional period would clearly be necessary.

21.102. Contributions to approved superannuation funds. The present tax treatment of contributions to superannuation funds is illogical and defective. Personal contributions are aggregated with life insurance premiums and are subject to a maximum deduction of $1,200 under section 82H, whereas contributions by an employer are, broadly speaking, deductible up to whatever amount will, when aggregated with the employee's contributions, produce a ‘reasonable’ benefit. This often results in different tax treatment of members of contributory superannuation funds vis-a-vis members of non-contributory funds. For instance, if the maximum overall contribution in respect of a certain employee that will not produce an excessive benefit is $3,000 per annum, then the tax consequences will be different if the contribution is divided equally between employer and employee than if the contributions are paid wholly by the employer. The differences will be accentuated where the employee is already using part of his $1,200 deduction under section 82H to pay life insurance premiums. It is hard to see the justification for this.

21.103. Subject to the conditions set out in the next paragraph, contributions to an approved superannuation fund should be an allowable deduction for both the member of the fund and his employer without any specific limit. There will of course be an indirect limit imposed by virtue of the fact that approved superannuation funds will be restricted to providing ‘reasonable’ benefits and, if contributions were to be made that would lead to benefits becoming excessive, they would have the effect of terminating the status of the fund and hence of the deductibility of such contributions. In particular, personal contributions by the member of the fund should be taken outside the ambit of section 82H, thus divorcing them from life insurance premiums.

21.104. Such contributions, to qualify for a deduction, must have some element of regularity about them, for otherwise employers and employees may tend to make large irregular contributions. This would be alien to the concept of long-term contractual saving which is one of the justifications for giving special treatment to superannuation, and would also lead to superannuation contributions being used as an income-averaging device. This assurance of regularity is best achieved by giving the Commissioner a discretionary power to disallow a deduction for large irregular contributions.

21.105. Provision for self-employed persons. The Committee has considered many submissions relating to the tax treatment of superannuation provisions for the self-employed. In the Committee's view it is necessary to take some steps in order to achieve a greater parity of treatment between employees and self-employed in this area. The proposals made above in regard to the taxation of benefits will apply equally to both categories of taxpayer. However, it is in the area of deductibility of contributions and maximum benefits that some change from the present system is needed. Owing to the fluctuations in the earnings patterns of self-employed persons, it is difficult to lay down the same standards of reasonableness for benefits as would be applicable to employees. Accordingly, it is proposed that the benefits to be provided from a superannuation fund for self-employed persons should, as now, be subject to overall dollar limitation. It is suggested that this amount be in the vicinity of

  ― 370 ―
$200,000. Moreover, contributions made by a self-employed person should be an allowable deduction up to a limit of 15 per cent of the taxpayer's personal exertion income from self-employment, averaged over the three years preceding the year in which the contribution is made. Provision should also be made for limited carry-forward of unused contributions. The figure of 15 per cent is chosen as representing the total of employer and employee contributions that could be expected in a reasonably generous superannuation fund.

21.106. Transitional provisions for superannuation funds. The proposals made above in relation to superannuation funds represent a significant departure from the present position and, as such, would give rise to a considerable amount of work for both the revenue authorities and the fund administrators before they could be fully implemented. The problems encountered after the 1964 and 1965 legislation indicate the need for a prolonged phasing-in period and for continuous consultation between fund administrators and the revenue authorities before the details of the legislation are settled and before the guidelines for the exercise of the Commissioner's discretion in various areas are determined.

21.107. The 30/20 requirements. The virtual compulsion on superannuation funds (and life insurance companies) to invest 30 per cent of their assets in public sector securities should be reconsidered. Compliance with the 30/20 rule need not be regarded as some sort of quid pro quo for the exemption from tax of the income of a superannuation fund: as already indicated, this exemption can be justified on other grounds. If the 30/20 requirements are to be retained, the Government should give consideration to the issue of special index-linked bonds, bearing a relatively low interest rate, which would provide that both principal and interest would escalate in step with the consumer price index or some other suitable measure of inflation. Furthermore, the Government should ensure that there is a market at all times for any security that a superannuation fund is required to hold.

The Second View

21.108. The second view adopts the proposals advanced in the first view, subject to five main differences. The first difference requires that a reasonable benefit from an approved superannuation fund, as described in the following paragraphs, should be a standard amount for which any employee or self-employed person may qualify. The amount of saving made by a person or in respect of him to be tax-assisted, up to a common stated maximum, will depend on capacity to save.

21.109. The second of the five differences is connected with the first and requires that the maximum amounts of contributions to an approved fund to be allowed as tax deductions should be limited only by a requirement that the standard amount of total benefit should be gradually built up.

21.110. The third difference requires that only benefits flowing from an approved superannuation fund should receive the forward-spreading treatment described in paragraph 21.77. This treatment involves a concession which should apply only to receipts that may fairly be said to be the return to the taxpayer of income invested by him or in respect of him by his employer in long-term saving the consumption of which has thus been deferred. Other receipts should be subject to anti-bunching provisions of the type proposed in Chapter 23 (paragraphs 23.34–23.37) for capital gains, unless applied in the purchase of an annuity in accordance with paragraph 21.73. Alternatively, the taxpayer would be able to make use of the income-equalisation scheme proposed by the Committee in Chapter 14.

  ― 371 ―

21.111. The fourth difference requires that an employee's interest in contributions made in respect of him by his employer, after a qualifying period, should be vested, in the sense that on retirement these contributions and accumulations of income will be available to him, or on ceasing to be a member of the fund other than by retirement they will be retained for him in the fund until he reaches retiring age, or they will be transferred to his account with another approved fund, or they will be paid to him and attract income tax. If the tax law gives its assistance to savings that are subject to forfeiture on the employee leaving his employment, it is assisting the restriction on mobility of labour that the prospect of forfeiture involves.

21.112. The fifth difference requires that there should be a complete assimilation of the tax treatment of a lump sum paid on retirement and a pension paid on retirement from an approved superannuation fund.

21.113. The first, second, fourth and fifth differences, more especially the fourth, would cause difficulties for many existing superannuation schemes and it would be necessary to give effect to them by new law which would apply to a person who is not a member of an existing scheme or who withdraws from an existing scheme.

21.114. This new law would seek to give effect to the following principles:

  • (a) The maximum amount of long-term saving for which any tax assistance can be expected should be the same for everyone.
  • (b) The maximum amount of the deduction against earned income available to a person for contributions to an approved superannuation fund should be the same for everyone.
  • (c) Contributions made by an employer in respect of his employee to an approved fund should be treated as income of the employee, but the total of those contributions and the employee's own contributions would be allowable deductions by the employee within the amount referred to in (b). Equality of treatment of the employed person and the self-employed person would in this way be assured.
  • (d) The fund to which contributions would be made must be an ‘approved’ fund—i.e. approved by the Commissioner or some other government authority which may take over his function. A cardinal condition of approval should be that an employee's interest in contributions made in respect of him by his employer is vested, in the sense explained in paragraph 21.111.
  • (e) To be approved a fund should give to the taxpayer a right to receive all contributions and accumulations in the form of a lump sum on his retirement. He may elect to take a pension, in which event he will be taxed on a notional receipt of the lump sum and will be taxed on pension receipts as if he had received the lump sum and then applied it in payment for the pension. In the result, the amount of each pension receipt that is a return of the payment for the pension will be free of tax. Equality of treatment of a lump-sum receipt and a pension would in this way be assured.
  • (f) A lump-sum receipt from an approved superannuation scheme should receive special income tax treatment, a portion up to a stated amount being exempt from tax and a further portion, where applicable, being subject to forward spreading. In today's circumstances, up to the first $50,000, say,

      ― 372 ―
    should be exempt from tax and up to a further $100,000 subjected to forward spreading over ten years by the method shown in paragraph 21.76(b).
  • (g) When the new law comes into operation, only schemes complying with it should be allowed to admit new members; and a person by or in respect of whom contributions continue to be made to a fund approved under the old law should not be entitled to join a fund complying with the new law.

21.115. The way in which some of these principles would be expressed in the details of the proposed law requires some elaboration.

21.116. The amount of tax-assisted saving. At present prices tax-assisted saving might be set at $150,000. The authority supervising approval of funds would need to be satisfied by the trustees of a fund that any member's estimated entitlement will not exceed the maximum on his retirement. For this purpose the authority need only be concerned with the amounts already standing to the credit of the employee or self-employed person and the estimated earning rate of the fund. If it appears that the maximum will be exceeded, the fund would not be allowed to accept contributions by, or in respect of, the taxpayer.

21.117. Contributions to the fund. The amount of contributions that may be made to a fund and that will be deductible against earned income should be set at a figure which, if made over a period of the full working life, will produce with accumulations an amount not exceeding $150,000, with provision for benefit on early retirement due to ill health and for dependants on the taxpayer's death. There should, however, be some increase in the amount of deductible contributions with the age of the taxpayer to allow for later entry into a scheme and to take account of inflation. The amount of contributions deductible should be reviewed annually. The employer's contributions to an approved fund are treated as employee contributions. The deductibility by the employer of his contributions will follow general principles in regard to the deduction by an employer of salary paid to his employee.

21.118. It is not contemplated that the increase in allowable deductions by reference to the age of the taxpayer should be such as to make any substantial allowance for late entry. Tax assistance should be given only to long-term saving.

21.119. Approved funds. The tests of approval should be applied to all schemes in respect of which tax assistance is claimed. Thus a fund that does not give an employee a vested interest in the employer's contributions would not be approved under the new law. Only an amount received on retirement standing to the credit of the employee's account in an approved fund would receive the treatment proposed in paragraph 21.114 (f). Exemption from tax on its income would be available only to an approved fund. Contributions would be deductible only if made to such a fund.

21.120. The taxing of receipts from an approved fund. Provided the amount received does not exceed the ceiling of $150,000, it will be taxed as proposed in paragraph 21.114 (f) if the taxpayer is over fifty-five or it is paid as a result of the death of the contributor or his early retirement due to ill health. The supervision of approved funds will not always ensure that the taxpayer's entitlement does not exceed this figure. To the extent that it does, the receipt by the taxpayer should be subject to tax in the same fashion as an unfunded retiring allowance.

21.121. If the taxpayer is not yet fifty-five at the time of the receipt and he has not retired due to ill health, the receipt should be treated as an unfunded retiring allowance and taxed as proposed in paragraph 21.110. However, the taxpayer should be

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allowed a deduction of a contribution he makes to another fund subject to the new law, and the fund should be allowed to accept his contribution, provided the contribution will not involve the consequence that the taxpayer's entitlement on retirement will exceed the maximum of $150,000. He will thus ‘roll-over’ his entitlement from one new fund into another.

21.122. A taxpayer who, in similar circumstances, receives an amount from a fund approved under the old law should also be allowed a deduction of any part of it contributed to a fund approved under the new law, subject to the same qualification. He will thus ‘roll-over’ his entitlement from an old fund into a new fund.

21.123. The phasing out of funds approved under the old law. The fact that only funds approved under the new law would be allowed to take in new members and the restrictions that would preclude a continuing member of a fund approved under the old law from joining a new fund, must in time ensure that old funds disappear. It might however be anticipated that old funds will tend to be converted to new funds.

21.124. Some employer-employee funds would continue, but the financial advantages of new funds for employees, other than those on high incomes, would generate a significant pressure for conversion. In addition, pressure for conversion would arise from the vesting of an employee's interest under the new law, which may not be available under the old law.

Comparison of the Two Views.

21.125. The two views put forward are alternatives but it is of course possible to construct other alternatives combining aspects of each. The Committee does not express a preference for one view over the other, and some members of the Committee would not wish to commit themselves to certain aspects of each view.

21.126. A comparison of the major aspects of the two views is briefly summarised in the following paragraphs.

21.127. The first view, in its application to employee superannuation, follows closely the present law in giving tax concessions to provisions for retirement benefits, which may not always involve long-term saving, if they are considered reasonable having regard to earnings from employment. The second view believes that tax concessions should be given only to long-term saving and that there should be a maximum standard tax-assisted benefit available to all persons in employment but not directly related to their employment earnings.

21.128. The first view also follows the present law in giving concessional tax treatment to a lump-sum payment on retirement whether or not any provision has been built up to meet the payment. Under the second view a lump-sum benefit paid on retirement other than from funds that have been built up from long-term saving would not receive any tax concession. Thus a non-funded benefit received from a scheme of the type now generally used in the public sector would not qualify for any concessional treatment in the hands of the recipient.

21.129. The basic approaches of the two views to achieve parity in taxing a pension benefit and a lump-sum benefit also differ. Under the first view pensions would continue to be fully taxable as at present and lump-sum benefits would fall to be taxed on the assumption that the total amount was to be paid by equal annual instalments over the fifteen years subsequent to retirement and that this instalment would be the sole annual income of the recipient in that period. Admittedly, true parity would not be

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achieved in this way in many instances. Under the second view parity would be sought by requiring that on his retirement an employee should always be entitled to take a lump-sum benefit. The first $50,000 of this lump sum would be exempt from tax and the balance of up to $100,000 would be subject to forward spreading on the basis applying under the first view but over a ten-year period. If the retired person elected to take a pension, he would be taxed at the time of election as if he had received a lump sum, and he would be exempt from tax on so much of the pension receipts as represented the sum he had applied in purchasing the pension. Parity in taxing a lump sum and a pension flowing from an approved fund would thus be substantially achieved.

21.130. Under the first view an employer would be able, subject to the Commissioner's discretion to disallow irregular contributions, to make tax deductible contributions for the later years of an employee's service in an effort to ensure that his total retirement benefit was reasonable in relation to his remuneration close to retirement and these contributions would not be income of the employee. Under the second view, where the approach is that only long-term saving should qualify for tax assistance, the consequence might be different. Although the employer would obtain a deduction for an additional contribution to meet this eventuality, the employee might be taxed on the additional contribution: he could fail to obtain a deduction for the contribution, which would have been treated as his income, because it exceeded the set maximum annual contribution for a person in his circumstances.

21.131. Under the first view it is not proposed that there should be a requirement that the employer's contribution for an employee's benefit be vested. Under the second view it is a basic principle that a contribution by an employer to an approved fund is to be allocated as being for the benefit of identified employees. The approach of the second view will therefore impose vesting on benefits flowing from contributions by both the employer and the employee to an approved fund.

21.132. Expenses in varying trust deeds to fit in with the first view should be minor and thereafter there ought to be no continuing added costs. Under the second view, which requires more substantial changes to the rules of existing funds, and in some cases the institution of new funds and the running down of old ones, the initial administrative costs could tend to be heavy. It also seems that there will be heavier continuing administrative costs under the second view due to the requirement to keep separate accounts for the contributions and share of earnings of all members of the fund, including some members who have left the employer's service but have not yet reached retiring age. In addition each employee would need to be advised annually of the employer's contribution to the approved fund for his benefit.

21.133. In the first view the present flexibility in the adoption of a type of fund—for example, an accumulating fund or an actuarial-type deferred benefit fund—would continue. Under the second view an accumulation-type fund only would in practice be permitted. An actuarial-type fund, which is now used by many business organisations, would be incompatible with the requirements of the second view: these funds by their very nature do not identify a specific contribution for each member or the annual division of the total fund in proportion to the actuarial liability of the benefit planned for each member on retirement.